We Buy Ugly Stocks

I'm sure many of you have seen the billboards: "We Buy Ugly Houses."

That's the motto of Dallas-based HomeVestors of America, which encourages its franchisees to buy fixer-uppers at $0.65 on the dollar, renovate them, and flip them. (Or at least that was the model five years ago, when the company was profiled in BusinessWeek.)

Value investing works pretty similarly, except that we mainly just sit on our butts after buying at a discount. Also, for the non-activists out there lacking a big enough stake to cajole management into unlocking value -- as Carl Icahn appears to have done recently at Chesapeake Energy (NYSE: CHK  ) -- you probably want to pay even less than $0.65 on the dollar when buying an ugly business.

Do stock prices really get as low as half of their intrinsic value, or less? Sure, it happens more often than you'd think. As Warren Buffett has quipped, "I'd be a bum on the street with a tin cup if the markets were always efficient."

Half-price sales result from a host of situations. Take the Gulf of Mexico oil spill last year. Investors fled offshore oil and gas stocks en masse last June, leaving outfits like ATP Oil & Gas (Nasdaq: ATPG  ) and Cobalt International Energy to get totally hammered. These stocks have doubled off of their post-spill lows.

Sometimes stocks go on sale for much less dramatic reasons. Something as technical as a deletion from an index like the S&P 500 can cause shares to tank as they get dumped by institutions. Another "special situation" of this sort is when a business spins off a segment into a separate publicly traded company. If that spinoff holds limited appeal, either because it's in a line of business the shareowners don't care about, or because the market capitalization is too small, or for some other reason that has nothing to do with the company's actual value, the newly public company may find itself abandoned and undervalued. Especially if it's ugly.

Speaking of ugly spinoffs
Marathon Oil
(NYSE: MRO  ) today announced that its board of directors has approved a plan to move forward with a spinoff of the firm's "downstream" business, which consists of refining and marketing assets, the Speedway gas station chain, and an oil pipeline system. That will leave Marathon to focus on its exploration and production activities in places like the Gulf of Mexico, Libya, Poland, and Angola.

Refining is a tough business. Some might say it is a bad business. ExxonMobil's (NYSE: XOM  ) declaration that we'd hit peak gasoline consumption back in 2007 made it pretty clear to this Fool that the future for refiners was not so bright.

True, shares of Valero (NYSE: VLO  ) and Western Refining (NYSE: WNR  ) have bounced back lately, but they're well off the highs of a few years ago. Occidental Petroleum (NYSE: OXY  ) , meanwhile, is within spitting distance of those levels.

Gas stations, with their razor-thin margins, are possibly an even worse business than refining. Pipelines are proven moneymakers, and this segment is an exception to the overall ugliness of the Marathon spinoff.

How to play it
How will shareholders treat the Marathon spinoff, to be named Marathon Petroleum Corp.? I don't know for sure. Today's share price pop suggests that current owners either believe the parts are worth more than the whole, or they're just plain happy to be rid of the downstream business. The post-spinoff trading will tell the tale.

At the right price, Marathon Petroleum could make for an interesting value proposition, especially given the attractiveness of the pipeline business. Ugly businesses, orphaned stocks, and unloved spinoffs are the sorts of things we've got our eyes peeled for at Motley Fool Special Ops, and this one's got some potential. Rather than buy the pre-spinoff Marathon hoping to sell the two pieces at a profit down the road, we prefer to sit back and watch how the spinoff trades later in 2011. Our approach might be different if oil-weighted E&Ps weren't looking close to fully valued today.

Chesapeake Energy is a Motley Fool Inside Value selection. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Toby Shute doesn't have a position in any company mentioned. Check out his CAPS profile or follow his articles using Twitter or RSS. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool owns shares of ExxonMobil. The Motley Fool has a disclosure policy.


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  • Report this Comment On January 14, 2011, at 1:15 PM, birge1 wrote:

    ugly stocks in o&g are simple--anything in the gulf plus anything dominated in gas. the gas mrkt is dead for the next 3 yrs til we clean house in wshngtn .... again. the industry is a victim of its own success. back in about 2005 when gas shortages drove up the price to $10+, the industry really started drilling the Barnette shale around Dallas. now comes the Marcellus on top of it. gas is in a glut. the new lng plants need to ship gas to foreign soil, not import it here. and the whole country needs to convert to natrl gas for fleets--intrst trks, ups, delivery trks, city buses, schl buses, taxis, postal trks, all govt vehicles. that would leave true gasoline for the public since we can't afford to convert.

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